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Walmart earnings: ‘Consumers are definitely trading down,’ analyst says

Cowen Senior Research Analyst Oliver Chen joins Yahoo Finance Live to discuss Walmart earnings, consumer spending, inflation, price cuts, and the outlook for profit growth.

Video transcript

JULIE HYMAN: We continue to watch shares of Walmart today. They're holding up. They're still up by about 5% after the company reported revenue grew over 8% in the second quarter. US same store sales jumped by 6 and 1/2% year over year. The retail giant also saw inventory gains narrow to 25%, improved its 2022 profit outlook, although it's still looking for a drop.

Joining us now to discuss all of this, Cowen senior research analyst Oliver Chen. Hey, Oliver. Good to see you. Thanks for being here to help us digest these Walmart numbers. What stands out to you after the company, obviously, has come out and had to cut its outlook? So how do things sort of stand now versus how Walmart has managed expectations?

OLIVER CHEN: Julie, great being here. What happened in the back half of July is that things actually got better. So we're encouraged. I would say the consumer is generally stable with a lot of caution points and rapidly changing. The consumer is definitely getting negatively impacted by inflation of gas and energy, but as gas prices came down a little bit, that also helped the end of the quarter.

So there are puts and takes that we're watching. It was a better than feared quarter. And we love Walmart for the long-term. We have an outperform rating. These rapid shifts in what consumers want has impacted the results. And the company is having to work through inventory, as well as marking down product. Walmart's always done a great job with everyday low prices and offering the consumer exceptional value.

And in this environment, that's a great thing to do because consumers are looking for deals and bargains. And as you all mentioned, consumers are definitely trading down. Walmart is also seeing the middle and upper income consumer come shop at Walmart as well.

BRAD SMITH: OK, so what does that tell you about the broader kind of economic landscape that we find ourselves in if you do have more of the upper end consumer that is actually trading down, if you will, to Walmart?

OLIVER CHEN: I think we're going to see a continued caution, particularly in the back half, with inflation being a big factor, the wealth effect being a big factor. And apparel as a category has experienced a lot of markdowns. What's really happening is backpacks, suitcases, swimwear, that's working. Sweatpants is not. And then the consumer needs to spend money on food. And food is experiencing tradedowns, too. Private label hot dogs and other categories are seeing more traction. So you have a very discerning consumer.

On the other hand, there's positives of a low unemployment rate, also savings dollars on the sidelines. So it's somewhat bifurcated about what's happening. And we like certain stocks at the very high end and luxury goods, and then we like exceptional value, like grocery outlet Walmart, Target, Planet Fitness, and others.

BRIAN SOZZI: Oliver, so if consumers are trading down to Walmart, what's the readthrough ahead of Target's earnings? Does that mean they're trading down from a Target? And then when you go into a Target, what are some of these sales trends at Walmart called out? What does that mean for an Ulta? Because they now have a lot of shops in those stores.

OLIVER CHEN: Yeah, Brian, we love Ulta as a top idea because beauty is relatively recession resistant. And consumers have been conducting self-care with skincare and haircare. Also cosmetics is a great category that benefits from consumers going out again. So overall, beauty should be a bright spot based on our readthrough and our research.

We're also favorable on Target. Keep in mind target's PE is at 14 times. Walmart's at 20. You also get a double-digit free cash flow yield at Target, which is a positive in terms of valuation. Target has done a good job really executing on value. And Target also guided earnings down. So they're well prepared to offer promotions as well.

And Target traditionally does a great job executing around events such as back-to-school. Today, Walmart also had constructive comments on back-to-school, which is very positive. Students who are getting subsidies for meals, some dollars are freed up for back-to-school shopping-- backpacks, et cetera. And people do need new clothes.

JULIE HYMAN: So I guess what I'm trying to figure out, Oliver, when we heard Doug McMillon on the call talk about that they're seeing more middle and upper income folks in Walmart stores who are presumably trading down, I'm wondering where they're trading down from. If Walmart is gaining market share, particularly in grocery in this environment, it's at the expense of whom? Do we have any hints?

OLIVER CHEN: Yeah, Julie, I think it's just more expensive grocers and more branded product. Walmart is the leading US grocer. And it won't be undersold. It goes for that everyday low price strategy. Walmart's also one of the biggest organic produce suppliers as well.

And Walmart has amazing curbside pickup. 90% of Walmart-- US is within 10 miles of a Walmart. So Julie, grocery's pretty fragmented industry as a whole. But as you can imagine, players like Whole Foods, other players, the tradedown is entirely possible. And we all grew up-- I grew up in Louisiana right next to the Supercenter. Grocery is important. The pharmacy does a great job, too. And those are all kind of essential assets.

BRAD SMITH: How many quarters are you looking out to, to really evaluate how long Walmart's cash position may continue to dwindle?

OLIVER CHEN: Yeah, Brad, we're encouraged because Walmart has a very robust balance sheet and a free cash flow generation that's powerful, also attractive dividend yield, Brad. And guidance to us seems conservative and well-planned for the back half. Guidance also seems prudent in terms of taking markdowns in Q3.

So Walmart traditionally is a low beta way to play the market. It's also a way to play the US consumer. The US consumer to us looks a lot better than others globally, given the lockdowns in Asia and given mixed cross-currents in Europe. So overall, we're very excited about the long-term picture here and valuation.

And Brad, keep in mind the future of Walmart is really an ecosystem. Walmart+, the deal with Paramount, thinking about advertising revenues for Walmart, too, which are very high margin, and this whole omni movement is really the future of retail. The future of retail is physical meets digital, curbside pickup, artificial intelligence, buy online, pick up in store, reserve in store, ship from store. These are all conveniences that the consumer of tomorrow needs and wants.

BRIAN SOZZI: Oliver, Walmart called out weakness in apparel. Now they're not exactly selling Louis Vuitton or tapestry Coach bags inside a Walmart. So if they're seeing weakness in apparel, what does that mean for a struggling retailer like Gap?

OLIVER CHEN: Yeah, the problem in apparel is basic apparel. We've also had weather issues where consumers just haven't been out there enough. What I would say is retailers that have had difficulty with apparel are likely to continue to have difficulty. Also, gas prices are still very much up on a year over year basis. That's a negative for going to the mall and traffic and wanting to shop close to home. And as you mentioned earlier, it's great to have everything under one roof.

Apparel is an interesting category right now. The basics are under pressure. But going out stuff is working quite well. So it's really about having the right kind of inventory. And Walmart will continue to markdown some of the older inventory that was not as successful. And that will be under pressure, too. Going out categories like fashion dresses, swimwear, that's all working very well, Brian.

JULIE HYMAN: All right, Cowen senior research analyst Oliver Chen, we were admiring the OC neon sign behind you, Oliver. Pretty cool.

OLIVER CHEN: Thank you. Great being with you guys.

JULIE HYMAN: Good to be with you. Thanks